It was a grisly end to the year for stocks. On December 24th, due to numerous fears (including that a recession was looming in 2019), the S&P 500 closed down 19.8% from its all-time high. And with about 66% of its component companies in full on bear markets (20+% declines), market panic was widespread that further massive declines might be coming.
While long-term dividend growth investing is the most proven method for wealth creation, that only works if you can ride out the market's inevitable and frightening downturns, including recessionary bear markets.
This is where dividend stocks shine. That's because a company that is paying a safe and growing dividend can help investors focus on the long term and avoid making costly mistakes, like panic selling in the face of attractive valuations and strong fundamentals.
Historically, US companies try to avoid cutting their dividends, even during recessions (unless it's absolutely necessary). That's why since WWII the average dividend cut for the S&P 500 during a recession/bear market has been just 2%, 16 times less than the average peak share price decline.
But in case you want to own the ultimate sleep well at night or SWAN stocks, it's tough to beat the legendary dividend aristocrats. These are S&P 500 companies that have raised their dividends for 25+ consecutive years.
Over the past 28 years, the aristocrats have managed to beat the market by 25% annually with (and largely because of) 18% lower volatility. The key to their success has been outperforming during downturns and keeping up with the bull market during expansions.
But if you truly want to feel safe no matter what the economy, stock market or interest rates are doing, then you can't beat the dividend kings. These are S&P 500 companies with 50+ consecutive years of dividend growth under their belts and represent the bluest of blue-chips (and the elite among the aristocrats).
Of course, as a value investor, I know that even the highest quality companies can make poor investments if you overpay. Due to their fame and unbelievable income growth track records, aristocrats rarely trade at large discounts to fair value. But fortunately, this beaten down and frightened market represents the best buying opportunities in years and so even dividend kings are now on sale.
Which is why I want to highlight Colgate (CL), Federal Realty Trust (FRT) and Lowe's (LOW), the three most undervalued dividend kings in America. These are all Grade A companies that you can trust to deliver safe and steadily growing income barring a full-scale economic apocalypse (another Great Depression). What's more, from today's prices they are all likely to beat the market, not just in 2019, but for many years to come.
Thus, I consider these three the best dividend kings you can own for 2019, with Lowe's being my absolute favorite recommendation of this venerable group.
1. Colgate-Palmolive: The Most Undervalued Dividend King In America
Founded in 1806, Colgate-Palmolive is one of the world's oldest and largest consumer staples companies. It sells its cleaning, personal care, and pet foods under such famous brands as Colgate, Palmolive, Protex, Speed Stick, Ajax, Irish Spring, Sanex, Hill’s, and Softsoap in over 200 countries around the world.
Not just are Colgate's sales highly recession resistant (during the Great Recession they actually went up 11%), but the company is also highly diversified by geography. 50% of its revenue are from mature developed economies but 50% are from rapidly growing emerging markets.
What's more, few companies have more experience in these important growth markets, given that Colgate opened subsidiaries in fast-growing economies decades ago.
That means that Colgate has a big advantage (including from hiring local executives) in knowing what consumer preferences are, and being able to adapt its product offerings to win market share.
Today, many struggling consumer staples giants (like General Mills (NYSE:GIS)) are paying a high price to break into the rapidly growing pet food industry. That's because consumers spend more per calorie to feed their pets than themselves. In 2018, the US pet food market was $30 billion in size, and according to analyst firm Grandview Research, by 2022 global pet food will be a nearly $100 billion market that's growing at 4.3% per year (slightly faster than the global economy).
While General Mills' $8 billion acquisition of Blue Buffalo forced it to freeze its dividend (breaking a 13-year dividend growth streak), Colgate acquired Hill's Pet Nutrition in 1976 and now sells that popular brand in over 80 countries. That's exclusive through veterinarians, specialty stores and e-commerce (yet again proving Colgate is among the first to skate to where the puck is going). Today, Hill's has the #1 market share in US vet clinics (recommended by 32% of vets for basic nutrition and 50% for sick pets), which is a strategy that Colgate has pursued throughout its product lines.
Specifically, the company focuses on producing great products that are recommended by professionals (like vets, dentists, and dermatologists) around the world. For example, 42% of global dentists recommend Colgate's toothpaste, more than double that of its nearest competitor (22%).
In addition, Colgate is looking to compete at every price point. In toothpaste, its prices range from $0.05 for the cheapest products (in places like India) to as much as $7.20 in the more affluent US.
R&D spend is about 2% of sales per year to develop new products best tailored to local markets. Colgate has 10 R&D facilities around the world, including in the US, Europe, Russia, China, India, and Mexico. In addition, the company spends about 10% of annual sales on marketing to help maintain the wide moat power of its brands (and thus pricing power).
This combination of local market knowledge, R&D, advertising and working with medical professionals is why Colgate's brands are so dominant including:
- #1 market share globally in manual toothbrushes (32%, double that of its nearest competitor)
- #1 in toothpaste (42% vs. next biggest rival's 15%)
- #2 in global mouthwash
- #1 in liquid hand soaps
- #2 in body cleanses and bar soaps
- #2 in fabric conditioners and dishwashing detergent
Even more impressive is how dominant Colgate has become in some of the fastest growing (and largest) emerging markets. For example, its toothpaste market share in Brazil is 72.4%, which is up from 61.9% in 2002. That's the benefit of being in that market for 71 years and learning consumer tastes better than your rivals.
In Russia, Colgate's toothpaste market share is 29%, three times that of its nearest rival. In India, toothpaste market share is 50% compared to its nearest competitor's 17%. In China, Colgate owns about 30% of the toothpaste market, triple that of its nearest rival. In Mexico, Colgate's toothpaste market share is a staggering 83%.
But while Colgate has proven itself effective at global growth, a big reason for its impressive dividend growth record (55 straight years of annual growth and counting) is thanks to its other major competitive advantage.
That would be economies of scale. Colgate has 320 manufacturing, distribution and R&D facilities located around the world that allows it to source inputs in bulk and at the lowest prices that meet its quality standards.
The company also uses advanced data analysis to cut costs to the bone, including its latest 2012 to 2019 global growth and efficiency program which is expected to ultimately save $540 million in annual costs (5% reduction in costs of goods). Those cost savings targets are up from an earlier $450 million target set a few years ago. Its returns on investments in this cost savings program generally exceed 30% and pay for themselves within three to four years.
A lot of those investments are in making its manufacturing facilities more efficient (LEED certified plants), minimizing water usage, and reducing packaging. That leads to not just lower costs but also lower environmental impact (25% CO2 emission reduction since 2002 is good PR).
Thanks to those efficiency improvements (including automating plants and distribution centers), Colgate's gross margins have steadily grown to an industry leading 59%. For context, its average rival's gross margins (revenue minus cost of goods) is just 27%. And the company's returns on invested capital or ROIC (a proxy for good management and capital allocation) has been relatively stable at 56% over the past decade. That's about five times greater than its average rival. The company is led by CEO Ian Cook, a 44-year veteran of the company who has overseen numerous restructurings over the decades to help the company grow to its current industry-leading position.
Management's long-term goal is to deliver 3% to 5% revenue growth and analysts expect that cost savings and buybacks will translate that into 6% to 7% long-term earnings, free cash flow, and dividend growth.
The point is that Colgate is a dominant name in consumer staples, with a strong focus on oral healthcare and pet food. Its commanding presence in the world's largest and fastest-growing emerging markets makes it among the best-situated consumer staples blue-chip to overcome its growth headwinds (see risk section) and continue delivering the clockwork-like dividend growth for which it's become so famous.
2. Federal Realty Trust: The Best Dividend Growth Record In All Of REITdom
Federal Realty Trust was founded in 1962 making it among the oldest REITs on earth (Congress created REITs in 1960). Today, the granddaddy of the REIT industry (and the only dividend king in all of REITdom) owns 105 premium shopping centers totaling 24 million square feet located in America's eight largest cities. These are leased to over 3,000 tenants and also contain about 2,700 apartment units (mixed-use properties make up 31% of its portfolio).
Now many investors might scoff at the idea of a shopping center REIT being a SWAN stock. What about the supposed retail apocalypse we've been hearing about for so many years? Rest assured that US brick & mortar isn't dying, but thriving. According to Mastercard (MA), US holiday retail sales grew 5.1% this year, the strongest growth in 6 years. What's more, today's retailers have adopted an omnichannel or "bricks and clicks" approach to incorporating online sales into their traditional infrastructure.
Yes, online sales are growing twice as fast as brick & mortar, but omnichannel traditional retail sales growth has never dipped below 2.5% over the past eight years, and even physical store sales (excluding online) never fell below 2%. That's even when the economy fell to its slowest growth rates of the current expansion (during the great Oil Crash of 2014 to 2016).
The key to understanding retail (and retail REITs) is that there is now a gaping chasm between top quality shopping centers and low-quality operators (the ones shutting down and going bankrupt). Federal Realty is 100% focused on only the highest quality properties.
In fact, when it comes to quality shopping centers, it is without peer. That's because its average property is located within three miles of 160,000 households with an average household income of $120,000.
When it comes to the population density and median household income, no other retail REIT can hold a candle to FRT.
Not just are Federal's shopping centers located in the largest, most affluent and prosperous cities in America, but its adjusted funds from operation or AFFO (REIT equivalent of free cash flow and what pays the dividend) are under long-term leases to very strong retail tenants. 26% of its centers are grocery-anchored.
Just 5.3% of its rent is from struggling retailers. The highly diversified tenant base is mostly made up of thriving retailers (like TJX, HD, and ROST), recession-proof businesses (pharmacies and grocery stores), or experiential tenants (like gyms). Or to put another way, most of FRT's tenants are e-commerce resistant and should be able to keep paying rent even in a recession (one is most likely coming in mid-2020).
You might be surprised to learn that as far as revenue goes, FRT's biggest single source is its apartments. In total, 19% of its revenue comes from entirely non-retail operations, including 8% from offices.
While most shopping center REITs saw their FFO/share collapse 40% to 80% during the Great Recession, FRT's fell just 9%. And while no other shopping center REIT has yet to return FFO/share to peak 2007 levels, FRT's is now 49% above it.
This focus on top quality and safe cash flow is what has allowed Federal Realty to become the only dividend king in REITdom, with an impressive 51 straight years of dividend growth, no matter what challenges were facing the economy.
Federal's latest quarterly earnings report showed strong fundamentals.
- Revenue growth: 5.4% (7.5% YTD)
- Same-store NOI growth: +3.5% (2% or more is considered very good in this industry)
- Lease spreads: +12% YOY
- Cash flow/share: +5.3% (4.7% growth YTD)
- Comparable (same property) occupancy: 95.2% (vs. 95.4% in Q3 2017)
One of the most important metrics for retail REIT investors to focus on is growth in cash flow/share (what pays the dividend) and the lease spread. The lease spread is the difference between current rent and new rent when leases expire.
Double-digit lease spreads are a sign of a quality retail REIT (FRT's spreads have been 10+% for the past 20 years) with excellent and thriving properties that will serve dividend investors well in the future. That's thanks to strong and stable occupancy of over 95% (90+% is good for a retail REIT). FRT's same-store NOI has averaged an industry leading 4% over the past decade.
Further proof of FRT's superior quality properties can be seen in its industry-leading rents and the fact that its lease spreads consistently outperform most other shopping center REITs (historically nearly double its rivals). For instance, even during the Great Recession (the worst since WWII), Federal's lease spreads never fell below 8%, while its peers saw negative spreads.
A key reason FRT is thriving is that it's constantly improving its properties including into "mixed-use" ones by adding value enhancing features such as 2,700 apartments (97.6% same property occupancy). Such mixed-use asset help drive stronger retailer traffic and increase the REIT's pricing power. Federal is planning on more mixed-use properties and will be adding offices, apartments, and hotels to more of its locations in the future.
In total, the REIT is currently working on $938 million in redevelopment and mixed-use projects that should achieve about 7.5% cash yields on invested capital (vs. a cost of capital of 4.3%). What's more, with 9.3 million square feet of potential land upon which to build further offices/apartments and hotels, FRT's long-term growth runway remains very solid.
Federal Realty is headed by CEO Donald Wood, who has been with the REIT for 21 years and CEO for 17. He has overseen growth through mix-use properties (been doing it his entire career) as well as modest amounts of acquisitions ($1 billion worth since 2013). And with the rest of the executive team averaging over 15 years at FRT, it's fair to say that Federal Realty has a very deep bench.
Management expects to deliver at least 6% long-term growth in cash flow/share which should allow it to deliver similar dividend growth. FRT management's proven track record of sound capital allocation and steady dividend growth through all economic, industry and interest rate environments should leave investors confident in the safety and steady growth prospects of their generous payout.
3. Lowe's: The Best Low-Risk Turnaround Story On Wall Street
Founded in 1946, Lowe's is the world's second largest home improvement retailer. Lowe's and Home Depot (HD) dominate the large but highly fragmented home improvement market. In fact, while Lowe's over 2,000 stores make it the second biggest player in its industry, it still has just 8% market share.
Lowe's enjoys a wide moat courtesy of the fact that few of its smaller rivals can match its vast array (an average of 35,000 products per store) of offerings. Nor do they have access to one of the industry's best and most automated logistics and supply chains. That includes an IT system that routes 80% of its merchandise through 15 highly automated regional distribution centers.
The competitive advantage of its supply and distribution chain (plus economies of scale from suppliers) translates into lower costs that Lowe's passes onto consumers and helps build and maintain market share. In recent years, Lowe's has also begun offering private label (it's own brand) and exclusive products.
Lowe's dominance in home improvement retail, surpassed only by Home Depot's, has served investors well, including 56 consecutive years of dividend growth. More impressive is that the dividend has grown at 23% over the past 20 years.
Naturally, that growth rate is slowing over time but remains the fastest of any dividend king.
Lowe's is currently in a turnaround, having decided to shut down its underperforming Orchard Supply and Mexican stores (plus 47 more in Canada and the US). As a result, fiscal 2018's results are going to be weaker than what investors are used to.
- Total revenue growth: 4%
- Comps (same-store sales growth): 2.5% (down from guidance of 3.5% at the start of the year)
- Adjusted EPS growth: 16% (largely due to tax cuts)
Overseeing the Lowe's turnaround is new CEO (as of July 2018) Marvin Ellison. The former head of J.C. Penney (JCP) has over 30 years of retail experience, including 12 years as a top executive at Home Depot. He also serves on the boards of FedEx (FDX), the Retail Industry Leaders Association and the National Retail Federation.
Ellison isn't the only new name at the company. Over the past year, Lowe's has made several changes to the board and poached some top talent from other companies including:
- the new Chief Digital Officer (in charge of online sales) - from Amazon (AMZN)
- a new head of merchandising (controls the product mix) - from Chevron (CVX)
- additional store executives (from JCP and HD)
- a new head of supply chain (from Walmart (NYSE:WMT))
- a new CFO (from CVS)
In addition, the average vice president at the company has over 25 years of experience in home improvement retail. Or to put another way, Lowe's executive team is now packed to the rafters with experience, top talent, and the right mix of people to achieve its ambitious restructuring goals. In fact, Morningstar's Jaime Katz calls the new management team "exemplary".
Lowe's plans include cutting 2018 capex by $500 million (redirected to repurchases of its undervalued shares) now that it won't be spending money on underperforming stores it's shutting down.
However, in 2019, the company plans to ramp up capex to $1.6 billion as it focuses on streamlining its supply and distribution chain (linking maintenance supply HQ with wholesalers) and minimizing purchasing costs. But 2019 is just year one of a three-year turnaround/investment effort.
Lowe's plans to expand its regional distribution centers to 20 (and automate them further). It also plans to build 79 new delivery terminals and an additional online sales fulfillment center. The company also plans to beef up its online store from 450,000 products to about 1.5 million, to better compete with Home Depot and Amazon (which also getting into the home improvement market).
Overall, investments into streamlining the supply chain are expected to be $1.7 billion over the next five years. In addition to improving inventory management in its stores, the company's new logistics and distribution network will allow it to grow online sales faster, via guaranteed 2-day delivery. Lowe's plans to improve its omnichannel capabilities by hiring 2,000 new computer engineers who will be able to handle 80% of its improved e-commerce capacity in-house. In total, Lowe's plans to invest $1.5 to $1.65 billion into its online sales channels over the next three years.
Another big initiative management has is automating its payroll processes, which sounds boring but actually means that store managers will have far less paperwork to do. As a result, the amount of time employees can spend with customers is expected to increase by 50% by the end of 2020.
Improved customer service is a great way to boost Lowe's moat even further. What's more, given that Lowe's wants to boost its sales with professional contractors (who spend bigger than DYI customers), this payroll automation, when combined with better inventory control should directly drive higher comps and revenue growth.
And since Lowe's turnaround is designed to be comprehensive, the company also plans to improve employee training, focusing on its new SMART customer service formula. This is designed to match Home Depot's famed customer service experience which has made it a favorite of DYIers and professionals alike.
Most of the turnaround efforts and restructuring will take place in 2019, though the process will continue through 2023. This means that investors aren't likely to see much better growth next year.
In 2019, Lowe's expects greater capex spending to cause free cash flow to come in at $4.9 billion, down 8% compared to the trailing 12 months. However, using the last year's worth of dividends, that amounts to a 29% FCF payout ratio. In other words, Lowe's will be investing heavily into improving and ultimately growing its business while still having plenty of free cash flow left over for buybacks of its undervalued shares.
But big spending and buybacks doesn't mean the company plans to endanger the balance sheet. Lowe's will be increasing its debt levels, yes, but plans to firmly remain under the 3.0 leverage ratio that is safe for most companies. And keep in mind that with an ROIC of 29% already compared to 4.1% average interest rates on debt, Lowe's additional borrowing will ultimately help drive strong cash flow and dividend growth in the future.
Lowe's plans to take on a total of $9 billion in new debt, which, even with much higher capex, will combine for a total of $25 billion in cash that can be used for shareholder returns.
Most of that will be focused on buying back stock, including about $7 billion in 2019. Combined with the first benefits of the restructuring that should drive adjusted EPS up 10% this year.
Management's capital allocation priorities are to focus on improving the business first and maintaining a safe and growing dividend. That includes by maintaining an adjusted EPS payout ratio of 35% (where it currently sits). This means that investors can expect about 10% dividend growth in 2019 from Lowe's. That's far slower than its historical norm but still rates among the best of any dividend king.
And over time, that payout growth rate should increase substantially. This is because management believes these restructuring initiatives will deliver 12% long-term operating margins and returns on invested capital of 35%.
To give you some context about just how big an improvement that would be for Lowe's, its operating margins have generally been stable around 7% to 10% over the past decade.
And ROIC (a proxy for quality management and good capital allocation) has been among the best in the industry and recently hit an all-time high of 29%. Thus, Lowe's is targeting a 25% boost to its operating margins and a 21% improvement in its ROIC.
Combined with additional stores opening in underserved markets (mostly cities) and stronger comps, analysts expect that these improvements in operating efficiencies can drive nearly 16% long-term earnings and free cash flow growth.
That, in turn, means dividend growth that should remain the highest of any dividend king and make Lowe's a fantastic blue-chip investment today. In fact, I recently added the company to my new Deep Value Dividend Growth Portfolio, which is 100% focused on undervalued low-risk SWAN stocks with long-term total return potential of at least 13% (this portfolio is beating the market by 8.3% so far).
Payout Profiles: Safe And Steadily Growing Dividends And Market-Beating Return Potential
The most important part of any dividend investment is the payout profile which consists of yield, dividend safety, and long-term growth potential.
All of these dividend kings are matching the market or offering superior yield. More importantly, those dividends are very safe thanks to modest payout ratios on strong cash flows.
The other half of the dividend safety formula is the balance sheet. Dangerous debt levels can imperil a payout that's well covered by cash flow if a future recession causes credit markets to slam shut (as occurred during the Financial Crisis).
|Company||Net Debt/EBITDA||Interest Coverage Ratio||S&P Credit Rating|
Average Interest Cost
At first glance, FRT's high debt levels might make its dividend appear unsafe. In reality, it's the safest in all of REITdom. That's because the average leverage ratio for this sector is 5.8 (industry average 5.7), meaning Federal's leverage is actually below its peers. Similarly, the interest coverage ratio of 5.4 is much better than the 3.4 REIT average. And with 99% of FRT's debt being long-term (10.5-year average maturity) fixed rate (essentially no interest rate risk) this explains why FRT is one of a just five REITs with an A level credit rating. This ensures it can borrow at low rates that ensure profitable long-term growth.
Lowe's plans to leverage up its balance sheet, but a 2.75 leverage ratio is still not going to put the dividend in danger. Especially once its restructuring investments kick in, in 2020 and boost its interest coverage ratio back to current levels and higher over time.
Colgate's balance sheet is the safest of all, as seen by its low leverage, sky-high interest coverage and one of the best credit ratings in America. And thanks to borrowing in foreign currencies (European interest rates are much lower), CL's effective cost of debt is below that of the US Treasury (2.9%).
As for long-term dividend growth, investors should expect payout growth to match long-term cash flow growth. Colgate's 6.5% FCF/share growth estimate appears reasonable; however, as I explain in the risk section, is far from guaranteed.
FRT's growth rate is harder to pin down with analysts expecting very modest 4% growth while management is guiding for 6+%. Given management's excellent track record on execution investors might see dividend growth roughly in line with the REIT's 7% historical rate.
Lowe's offers the fastest growth potential of any dividend king, which is why it's my favorite recommendation of this venerable group.
Overall, even assuming no valuation changes over time, all three companies should deliver market-beating total returns. But when we adjust for their current valuations, literally the best of any dividend kings, then the investment case for all three blue-chips becomes even stronger.
Valuations: Wonderful Companies At Great Prices
Given the overall stock market's terrible year, it's no surprise that none of these dividend kings have put up especially excellent returns (though LOW and FRT did manage to beat the S&P 500). But that should get value-focused income investors excited because each is now trading at a very attractive price.
That's based on my favorite valuation method for blue-chip dividend stocks, dividend yield theory or DYT. This is a system made famous by asset manager/newsletter publisher Investment Quality Trends in 1966. That's when they began exclusively using this simple but powerful approach on blue-chip stocks that meet four out of their six quality criteria (including 25 years of uninterrupted dividends).
How good is DYT? Well, IQT's results speak for themselves. They've delivered decades of market-beating total returns with 10% less volatility to boot.
DYT merely assumes that, if a company's business model doesn't fall apart (thesis breaks), then the yield will be mean reverting over time. Or to put another way, the yield will tend to cycle around a relatively fixed point approximating fair value.
|Company||Yield||5-Year Average Yield||13-Year Median Yield|
Estimated Fair Value Yield
As you can see, that's certainly the case with these three dividend kings. The five-year average and 13-year median yields are nearly identical, meaning that DYT offers us a good estimate of where we can expect the yields to return to in the future.
|Company||Discount To Fair Value||Upside To Fair Value||10-Year CAGR Valuation Boost|
Valuation-Adjusted Total Return Potential
|Federal Realty||15%||17%||1.6%||9.2% to 11%|
Each of these dividend kings is between 15% and 21% undervalued and share prices are likely to outpace cash flow and dividend growth in the coming years. Over the next decade, that translates into CAGR valuation boosts of 1.6% to 2.4% for these stocks. Add that boost to the Gordon Dividend Growth Model (highly effective for dividend stocks since 1956) and you get a valuation-adjusted total return potential (TRP) of yield + long-term cash flow growth + valuation boost (return to fair value over time).
Thus, each of these kings is trading at attractive discounts that translates into double-digit expected returns over the next decade, with Lowe's offering the strongest TRP of any dividend king. That's why it's personally my favorite dividend king recommendation right now and the only one of these three that DVDGP owns (due to our 13% TRP requirement).
But of course, anyone considering investing in any company, even a low-risk dividend king, must first understand and be comfortable with its risk profile.
Risks To Consider
While these three dividend kings are low-risk income investments, that doesn't mean that they still don't face plenty of challenges in the future.
In the case of Colgate, its large global diversification means it has a lot of currency risk as well as exposure to economic downturns in more volatile economies (many who are dependent on commodity exports). Today, the US has the only positive inflation-adjusted central bank interest rate of any developed economy which has caused a strong dollar to hurt multi-nationals like Colgate.
What's more with China (the primary growth engine for emerging markets) now suffering through its second slowest growth in 25 years, the company might continue to struggle to achieve anything close to its historical organic growth rates.
Even in more stable economies like the US, Colgate faces growth headwinds in the form of generic products which have become more popular in recent years. According to Nielsen, generic (private label) consumer brands are growing three times faster than name brands, and recently hit 20% market share. By 2027, the analyst firm expects that to reach 26%.
Generic products are usually sold under a retailer's own brand and are typically more profitable. This poses a big risk to Colgate because sales to big customers (Walmart accounts for 11% of total revenue) might come under threat. As Walmart and other big retailers like Target (TGT) and Costco (COST) adapt to e-commerce, their margins are coming under pressure. Thus, the appeal of private label products grows and, combined with the ease with which online sales allow consumers to switch brands, could put major pressure on Colgate's wide moat and pricing power.
That pricing power is what the company has depended on to offset rising input costs over time (inflation). Its recent weakness in organic growth (a problem faced by all consumer staples giants) is a big reason that its FCF/share has struggled to grow over the past decade and why its dividend payout ratio has risen from 50% to 58% over the past 10 years.
Basically, Colgate, like many famous consumer staples aristocrats/kings, must continue to adapt to changing consumer/retailer tastes. If it can't, then its long-term growth goals might not be achievable.
As for Federal Realty Trust, the big risk is that as more retailers shift to omnichannel, the importance of physical stores might decrease. This could put pressure on the REIT's historically high lease spreads. While Q3's 12% YOY spreads were still solid, they represented the slowest growth in seven years. Morningstar's Kevin Brown expects FRT's lease spreads to fall into the high single digits over time, and this is a big reason that analysts expect the REIT's future cash flow and dividend growth to slow to about 4%, far below its historical norm of 7% (and below management guidance).
One reason for that slower growth might be having to periodically deal with struggling tenants (which make up about 5% of rent). While these stores will eventually be re-leased to stronger clients, dealing with potential store closures in the future could still ding cash flow growth and lease spreads.
Investors will want to watch the REIT's fundamentals closely, especially lease spreads (broken out in each earnings report) to make sure that FRT is achieving these strong enough growth metrics. While even slower growth can still lead to good returns, should management fail to achieve these more conservative estimates then long-term total returns will disappoint or at least miss its 6+% long-term growth target.
And of course, while REITs have no long-term sensitivity to long-term interest rates, in the short term, they can be highly rate sensitive.
While long-term interest rates have likely peaked this cycle, investors in FRT need to keep in mind that this dividend king, like all of them, will at times become volatile. This is why the right asset allocation (mix of cash/bonds/stock) is important. FRT is a great choice for the stock portion of your portfolio due its high dividend safety and fantastic fundamentals. But in the short term, the market's stupidity can be infinite and even world-class companies can fall off a cliff (thus, the need for cash/bonds in most portfolios).
As for Lowe's, my favorite dividend king recommendation right now, the big risk is that management's ambitious efforts at its restructuring take longer than expected or fail to be fully realized. Poor supply chain causing inventory issues was the big reason why the company's Q3 comps came in at a very weak 1.5% (by comparison Home Depot's was 5%).
What's more, we can't forget that restructurings cost money and that is going to hurt the company's earnings and FCF in the short term. In Q3, the restructuring charges ($280 million for store closures) resulted in EPS shrinking 26%. Investors are going to have to, like management, take a long-term view and be patient during this three-year turnaround.
However, also be aware that since Lowe's is a cyclical business (sales and profits fall during recessions). So even once the big restructuring work is done in 2019 and 2020, the company's top and bottom line growth might disappoint. It all depends on the timing of the next recession, which is likely to deeply hurt the already struggling home construction market.
The good news is that with Lowe's very strong balance sheet and low payout ratio, the dividend is not just going to remain very safe, but likely keep growing at a fast clip (for a dividend king). But the next few years might see dividend growth dip into the low double digits or even high single digits. Basically, with Lowe's the big risk is that Wall Street, not famous for its patience or long-term thinking, will punish the stock while investors see much slower dividend growth than they are used to.
Fortunately, over time, we should see mid-teen payout growth if the new rock star management team can deliver on its restructuring and growth goals.
Bottom Line: Colgate, Federal Realty And Lowe's Are The Best Dividend Kings You Can Buy For 2019 And Beyond
Warren Buffett, the greatest investor in history, once said: "it's better to buy a wonderful company at a fair price than a fair company at a wonderful price." For companies of Colgate, Federal Realty's, and Lowe's caliber, legendary dividend kings and SWAN stocks, I can whole heartily endorse buying them at fair value or better.
So when these three are trading at 15% to 21% margins of safety, I consider it a great time for conservative income investors to load up on some of the best companies in America (and indeed the world).
Each of these stocks is likely to not just deliver safe and growing dividends in all economic and market environments, but being the most undervalued dividend kings in America, also deliver market-beating returns in 2019, as well as the foreseeable future.
If you can only afford to buy one of these world-class blue-chips, then I consider Lowe's the best dividend king to buy for 2019. That's because I'm confident in the new rock-star management team's ability to deliver on its turnaround plans and thus deliver long-term dividend growth of about 16%, by far the fastest of any dividend king. Which when combined with its current valuations should result in the strongest total returns over time of close to 20%.